원문 보기
Generally, when it comes to testing or medical diagnosis of any disease, there is an expectation of accuracy. Yes absolutely. I mean, like in engineering, if a bone breaks, a white crooked line is visible in the X-ray and the doctor points and says that yes, this is the problem. There is a binary situation.
It is either broken or not. Right? Completely black and white. And there's a strange comfort in that because the human mind doesn't want things to be clear. They can be divided into different categories. You are absolutely right. Human psychology always seeks certainty. But the problem begins when we enter the world of financial markets and investments.
There the X-ray machine gets completely damaged. Good. Yes. An investor stands at a place where the relationship between cause and effect is very blurred. And in today's special discussion, we will try to find a way through this ambiguity. I was recently watching a very famous interview with investing legend Howard Marks.
78 Years of Investing Wisdom in 60 Minutes. Oh wow. It is truly a masterpiece. Isn't it ? He said some things that completely reverse our common understanding about the stock market. Generally, a new investor thinks that he will make big money in the market only when he finds the next Google or the next Amazon.
Same crowd thinking. Exactly, he is always looking for winners. But Howe Marks' entire philosophy is based on the fact that an investor can earn much better and safer returns simply by controlling his risk by keeping losers out of his portfolio. No, it is really the biggest paradox of the market. In the world of investing, being the best doesn't mean generating the highest returns.
The real game is about risk control. Risk control. Right? Yes. A common investor always looks at the upside, how much the money will double. Whereas a seasoned investor always looks at the downside of how safe the capital is. Howard Marks emphasizes that successful investing is not a rigid formula. This How to Think is a way to develop a specific mindset.
So to understand this how to think practically, an article by Charlie Ellis, The Loser's Game, has been cited in this source material. Which really made me think. That article by Charlie Ellis is very insightful. Of course he has drawn a comparison between professional tennis and amateur tennis. He says that professional players like Rafael Nadal or Roger Federer win because they hit winning shots that reach the corners of the court where the opponent cannot reach.
Yes, his precision is amazing. Right? His victory depends on his brilliant shots. But amateur tennis is a completely different sport. One doesn't need to hit a perfect backhand smash to win in amateur tennis. There the player wins simply because he consistently sends the ball across the net. Unless the opponent player makes a mistake and hits the ball out of the court or over the net.
Which is called unforced errors in tennis language. Exactly unforced errors and this concept applies directly to investing. The stock market is a loser's game for the common man. Winning here does not mean beating the market but protecting yourself from being defeated. Meaning minimizing your own mistakes.
Yes, if an investor excludes assets in his portfolio that can go completely to zero, then the remaining good investments automatically give a long and strong compounding effect. Okay wait wait. I would like to offer a little push back at this point. Say. If we are talking about playing defensively. Meaning, if a player is playing only to not lose, will he ever be able to make big profits?
If we play with fear then where will the returns come from? This is a very valid question. But the problem here is that people associate safety with perfect quality. Which is another huge mistake. How? Let me explain. Howe Marks gives a very interesting example of Mike Milken. When he was new to the world of high yield bonds in 1978.
Milken explained that when an investor buys triple A rated bonds of a company that looks perfect to everyone. The risk is highest there. Wait wait wait. If a bond is triple A rated, it means it is the safest company. If he is financially strong then how can he be the biggest risk? This seems to be against common sense.
On the face of it, it seems logical. But the thing is that the pricing mechanisms of the market work differently. The price of a triple A rated bond is based on the expectation that the company will always be perfect. Perfection is already priced in the price of that bond. Well I get it. Meaning everything will go well.
is deemed. Absolutely. This time the company is already at the top. From there on there is no scope for improvement. If there is even a slight decline in the earnings of that company or any small negative news comes, then the price of that bond falls rapidly due to broken expectations. Here the upside is zero and the downside is wide open.
Oh wow. Now I understand the mechanics of it. When the market has integrated perfection into the price, any small mistake directly hits the valuation. You read it absolutely right. And on the contrary, Mike Milken said that if money is invested in single B bonds, which were called junk bonds, then the asymmetries change.
There is a fear of sinking in junk bonds or those. Yes, there is a risk. Single B bond means that the market has accepted that this company is going to go bankrupt. Therefore, their price is dirt cheap. Now if that company had not gone bankrupt. If it simply survives and runs its operations well, suddenly the market recalculates its default risk.
Because she did not drown. Exactly the rating of that bond can be upgraded. Credit spreads tighten and its price goes up like a rocket. So this simply means that safety does not lie in how good the asset is, but rather in how low people's expectations are from it. That is the most important thing. If expectations are zero, then every positive development is a bonus.
And this is where we enter the most important part of this source. Price versus value means the difference between price and value. Often people think that a good company is a good investment. This is perhaps the biggest myth in the capital markets. Often investors go to a store. They like the product there.
They like the management and buy shares of that company without thinking. Yes, this is very common. But the value of any asset cannot be determined unless you know what price you are paying for it. Even a world-class business can become a disaster investment if bought at a very high price. The most classic example of this is given in the source of Nifty 50 era from 1968 to 1973.
At that time, companies like IBM, Zerox, Coca-Cola and Kodak were dominant in America. Yes, yes, that period is historical. Right, these were the companies that the market called one-decision stocks. Just buy once and forget about it because it will never sink. Hmm. But what mistake did people make?
They paid PE ratios of 80 to 90 times for these companies instead of the typical PE ratio of around 16 at that time. I mean they thought that if it is of high quality then buy it at any price. This was a very dangerous thought. And the math behind this overvaluation is very ruthless. Absolutely. If a company is trading at a PE of 90, it means the market has factored in double-digit growth for the next 20 years into today's price.
As the economic slowdown hit in 1973 and the growth of these companies returned to normal levels, their multiples compressed. Whereas the company was still good. Yes, the company was still making profits, the product was still good. But the valuation fell from 90 PE to 15 PE. The result was that investors had to suffer losses of 80 to 90%.
Oh my God! If I understand this with the example of real estate because buying a car or a house is more understandable to common people. Yes, try it. Suppose an investor buys a luxurious penthouse in a very prime location. But at a price three times higher than the market rate. Of course that property is excellent.
The marble is top class. But if he has paid a price that already covers the rent and appreciation for the next 10 years, then he has no margin of safety to make a profit. It's a perfect analogy. And on the other hand, if a distressed and junk- looking property is available at half the price of the land itself, then the scope of loss almost ends.
This is why Howard Marks questioned when rating agencies like MES declared B rated bonds as bad investments. MES only looked at the credit quality of those bonds. Ah, I didn't see the price. He ignored the price. Exactly. They didn't consider that if this junk bond was available at 20 cents on the dollar , it had more potential for profit than loss.
Good and bad are identified not by the asset but by its price. But now a practical problem arises here. It is okay to buy at a cheap price. I've got it. But the basis of that cheap price is tomorrow 's profit. And no one has seen the future. So how should an investor measure risk amid this uncertainty?
This is a long and deep question. The source here makes a deep reference to Nassim Niklas Tellib's book Fooled by Randomness. And Talib explains that there is a huge difference between market and science. Exactly science and engineering follow fixed rules. If you turn on an electrical switch, the light will glow because the cause and effect are fixed there.
But investing is a social science. Meaning it depends on the behavior of people. Yes, here the behavior of market participants changes the market. Randomness plays a big role here. That's why Telep says risk does n't mean buying at a cheap price or volatility. The real meaning of risk is that more things can happen than are likely to happen.
Wait, that's a very profound statement. There are more things that can happen than are likely to happen. This means the models we create only cover a few possibilities. Whereas in the real world there is always a possibility of something completely different happening. And that's why ah macroeconomic forecasting or market predictions often don't work.
John Kenneth Galbath said that forecasting only inflates the ego of the forecaster. It does n't make money. Why so ? I mean people hear a lot of predictions on TV. It is important to understand its mechanism. Suppose the consensus is that the economy will grow by 2% in the coming year. The market has already incorporated that information into today's price by discounting it.
So taking a trade on that correct forecast will not bring any extra profit. Because everyone already knows that. That is it. And if someone makes a contrarian forecast that is completely different, then the chances of it being wrong are mathematically very high. So how to avoid risk in this randomly moving world ?
Howard Marks quotes a very funny and slightly dark saying on this. Don't forget the 6-foot tall man who drowned in a river whose average depth was 5 feet. Yes, it sounds like a joke, but the lesson is huge. It sounds funny when you hear it for the first time, but there is a big rule of statistics and survival hidden behind it.
Right? This example explains the difference between expected value and standard deviation. An investor's portfolio may be designed to generate a 10% return each year on average. Its expected value is positive. But reality does not move in a straight line. There are ups and downs. Yes. The average depth of the river may be 5 feet but at one place in the middle it may be 10 feet deep.
If an investor takes too much leverage on his portfolio or trades on margin, then a big fluctuation, that 10-foot hole, can wipe out his entire capital. Survival is the first condition in investment. If the capital itself is lost then the average return of tomorrow is of no use. Exactly game over. This means that risk assessment is not just about whether my analysis is correct but also about whether I have the ability to survive in the market if my analysis proves wrong for a few years.
You are right and for this sustainability and to stand out from the crowd, Howard Marks introduces the concept of second level thinking. He believes that if an investor is thinking the same thing as everyone else, then his returns will also be average. This is the most critical part of the entire analysis.
See, the difference between first level thinking and second level thinking is what differentiates an ordinary and extraordinary investor. First level thinking is very simple and straightforward. Like it's a very good company. Its profits are increasing. Buy its shares. This is the linear approach that everyone in the market is seeing.
Well, second level thinking goes a little deeper than this. Yes, it calculates the company's financials as well as the market psychology. Second level thinker will say yes this company is good. But everyone in the market knows about it. Everyone has already bought this stock based on this good news.
Due to which its price has gone much above the intrinsic value. So what will be its action? The action will be that he will think that now since everyone has bought it. There will be no new buyers left and if even a little bad news comes, there will be panic selling. So let's sell it. Wow! It changes the whole perspective.
And due to this lack of second level thinking, a situation like race to the bottom arises in the market. When central banks reduce interest rates to near zero, investors move away from risk-free assets and start desperately chasing returns. Like it happened a few years ago. Yes. If they want fixed income, they start investing in high yield risky bonds without any analysis.
In this race, investors are ready to give up all the protective factors or safety conditions that could have saved them from the downside. They completely forget the risk and just chase the returns. But in all this, one question comes to my mind. If active investing is that complex where an investor has to look at price versus value.
Randomness has to be fought. Second level thinking has to be applied and compete against institutional money. So, isn't it best for a new investor to skip all this and quietly opt for passive investing or index funds ? Many people feel like this nowadays. I mean, there is no forecasting or stock picking in passive index funds.
Just track the market benchmark. Isn't this a safer approach than actively controlling risk ? Look, this is a big illusion of passive investing. I believe index funds have definitely solved a big problem. That is manager risk or the risk of underperformance. Most active fund managers are unable to beat the market index after taking fees.
By buying an index fund, an investor is assured that he will not lag behind the market average. Yes, and the cost is also less because the management fees are negligible. Absolutely, but the mistake here is regarding structural risk. Index funds only remove the risk of underperformance compared to the benchmark.
It does not eliminate the risk of the underlying asset. Meaning asset bubble risk. Exactly. A market cap weighted index fund invests most of your money in companies whose valuations have increased the most. If the market is in a bubble, then the index fund automatically becomes the biggest shareholder of that bubble.
Oh right. What is expensive becomes bigger in the index. You are right. And when the entire market crashes, the entire capital of the index fund will also fall at the same speed. Passive investing guarantees you to flow with the market trends. But it does not give you capital protection or downside risk control.
The end is inevitable if we don't pay attention. We are at the end of today's discussion and if I were to sum up this entire deep dive, the essence of Howard Marks' philosophy is that an investor should focus most on removing bad assets from his portfolio. Absolutely. Defense first. Like an amateur tennis player, if we stop taking unnecessary risks and making unforced errors, time will automatically compound our investments.
Also, recognizing the difference between the quality of acid and the price of acid is the most important link. And along with this, another concept which I found most practical in the source is regarding time horizon and patience. Hmm. As How Marx says, there's no difference between being way ahead of your time and being wrong.
This statement is worth writing on the wall. Yes, if someone uses second-level thinking to identify a market bubble and takes a short position, but the market remains irrational and expensive for the next three years, then that investor, despite being technically correct, may become practically bankrupt.
Because the irrationality of the market can last longer than the solvency of an average investor. perfect. Therefore, along with conviction, capital endurance, i.e. the discipline of staying in the market while bearing losses, is greater than any theoretical knowledge. Before I leave, I would like to leave one last thought here regarding the conclusion of this entire discussion.
Nowadays, the trend of passive investing and index funds has increased so much in the financial world that crores of rupees are being pumped directly into the index every day without any human analysis. Algorithms and passive flows are deciding what the price of a stock should be. And it continues to grow.
So just think about it. What will happen on that day when there will not be a single active investor or second level thinker left in the market who can estimate the earnings of a company, its model and its actual intrinsic value. When everyone is just following the crowd without price discovery. This in itself would be a very scary as well as interesting situation.
Will market efficiency completely break down on that day? And if this happens, then wo n't it become the biggest treasure ever for the few active investors left in the market at that time because then the gap between value and price will be so big that no one else will be able to recognize it. In the future, perhaps that X-ray machine will be repaired again and some people will be able to see clearly where there is harm and where there is benefit.
Everyone should think about this. Absolutely. Please consider this last thought in private. Thank you so much for joining us for this insightful discussion today.
댓글 0